Dearer iron ore may dampen rate cut

A rebound in prices for iron ore – Australia’s number one export – may have reduced the need for urgent Reserve Bank of Australia interest rate cuts, according to economists.

Plunging commodity prices in August were an important factor in the decision by Reserve Bank policy makers to cut official interest rates by 0.25 of a percentage point to 3.25 per cent in October, one step from the emergency low it hit in the aftermath of the 2008 global financial crisis.

The bank signalled that falling commodity prices would trigger a sharper-than expected drop in the nation’s terms of trade, a key measure of income from exports.

They also highlighted the risk that the resources investment boom may peak as early as next year – forcing the bank to ease monetary policy in support of the non-mining sectors of the economy.

While the majority of economists expect the Reserve Bank to deliver a second reduction in as many months on Melbourne Cup day, financial markets have sharply discounted the chance of a cut.

Iron ore prices have risen by 15 per cent since the RBA’s October 2 policy meeting, helping to restore the value of this critical export commodity and encouraging companies such as
Fortescue Metals Group
to consider resuming stalled expansion projects.

A number of high profile forecasters, including ANZ Bank, have switched their forecast for next week’s rate meeting to “no change", though in part because there was also a stronger-than expected third quarter inflation report.

Core inflation accelerated to an annual 2.5 per cent in the three months through September, landing it in the middle of the Reserve Bank’s 2-3 per cent target range.

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Citigroup Australia economist Joshua Williamson said the rebound in iron ore prices may be reducing the bank’s scope to cut next week.

“This iron ore price makes the currency seem a little more palatable" to the Reserve Bank, said Mr Williamson. He said the recovery in metals prices would help them build “a good case for leaving rates on hold."

Iron ore plunged to a three year low of $US86.70 a tonne on September 5 but has rebounded to $120 capping a 15 per cent gain in October.

A recovery in Chinese steel prices has seen producers add to their existing stocks helping to push up prices from last month’s lows. China’s daily steel output climbed by 4 per cent from October 11-20 compared with the first 10 days of the month, according to Reuters.

Annette Beacher, a senior economist at TD Securities, said there was more scope for the Reserve Bank to remain in “wait and see mode".

“Many things are very different to early September when so much data surprised to the downside…look at the iron ore price recovery and the pop in underlying CPI," she said.

Barclays economist Kieren Davies said the Reserve Bank would be relieved that the iron ore price had rebounded.

“At least the hit to profits from export earnings won’t be as big as what it seemed back in September," he said. However Mr Davies was not convinced the price recovery would necessarily lead to renewed investment in the sector.

He said the RBA would also be aware that a turnaround in resources investment was still likely to be large when it comes.

“Even with the rebound [in iron ore prices] there’s no sign the mining companies want to rethink their capex plans," he said.

BHP ferrous and coal head Marcus Randolph told the Australian Financial Review that the industry needs to get used to volatilty in prices.

“I think that volatility in iron ore prices is going to be the way that it is, particularly since we’ve had prices at very high levels," said Mr Randolph.

“What has happened is kind of two classical facts. One is the supply side was severely constrained because all of the projects got cancelled three years ago, and the second, Chinese demand surprised on the upside. That is why the iron ore market has been fantastic. But do you think it is going to repeat itself? Probably not."

BHP earlier this year shelved a plan to build a $US20 billion outer harbour at Port Hedland which could have added 100 million tonnes of annual production to the 174 million tonnes of ore the miner produced last year.